This is part 3 of a multipart series on using buckets to define a dividend growth portfolio. Part 1 covered an introduction to using buckets in a dividend growth portfolio and why it makes sense for DGI investors. Part 2 focused on the "high yield" bucket and how it can fit into an investor's portfolio. While investors can define buckets in any way that works for their unique goals, this series is covering the following:
Core dividend growth
High dividend growth
Non-dividend
ETFs
This article will cover the core dividend growth bucket. The "Core" bucket is the backbone of a DGI investor's portfolio. This bucket will consist of the strongest dividend achievers; typically, these will have long histories of growing the dividend. Stocks in this bucket will generally have yields in the 2-4% range and 5-10% dividend growth rates. Of course, every individual can define this bucket to fit their goals.
The core dividend growth stocks should be low maintenance. The term SWAN, or sleep-well-at-night, is thrown around a lot, but if there were ever a group of companies that fit this description, they would fall into this bucket. These are companies a DGI investor plans to hold forever. An investor should focus a lot of upfront energy on buying stocks for the core bucket but should be almost bored by keeping them-except when the dividend checks roll in like clockwork!
While no company is risk-free, the companies in this bucket should have no glaring issues. As of 2020, a prime example of a core company would be Johnson & Johnson (JNJ). This company has the highest possible debt rating (better than the US government!), increased the dividend annually for over 58 years, has a starting yield of around 2.5%, and a dividend growth rate of over 6%. And yet, Johnson & Johnson still has risks.
Every recall at Johnson & Johnson becomes doom and gloom for the company in our sensationalized news media. Yet the company does just fine. The news stories are just noise. However, real risks exist from competitors, health care reform, or any number of unforeseen situations.
The critical thing to notice is none of these are pressing and evident at the moment. An investor should monitor all core stocks and the story evaluated. Just don't overthink it. These are SWAN companies.
Tiering the bucket
While your prototypical core dividend growth holdings include companies like Johnson & Johnson, many slightly lower quality companies may also be considered core. Often, there are compelling reasons to believe a company with a shorter dividend growth history is a future dividend champion. Other times, a company may struggle to meet an investor's dividend growth expectations, make questionable management decisions, or have a cloudy future, despite long dividend growth histories.
Examples of tiering in my portfolio are below (These are nowhere near my entire holdings, just typical examples):
Tier 1 - Core Companies
Company | Years of Growth | 5-Year Growth Rate |
Texas Instruments (TXN) | 17 | 21.6% |
Medtronic (MDT) | 43 | 10.3% |
BlackRock (BLK) | 12 | 10.7% |
Clorox (CLX) | 43 | 7.5% |
MSA Safety (MSA) | 49 | 6.1% |
Lowe's (LOW) | 58 | 17.1% |
(source: Wyo Investments)
There are a couple of things to look at in these examples. Blackrock has only a twelve-year dividend growth history. This history is shorter than I consider safe, which is usually 15 years of growth. However, it has excellent fundamentals, and I believe in its "story." That is, I think it will be raising dividends 20 years from now. Apple (AAPL) and Intel (INTC) are two other companies with short histories that I consider top tier.
Both Texas Instruments and Lowe's have very high dividend growth rates. Some investors might choose to place these into a "High-dividend growth" bucket. However, I consider that bucket more speculative, whereas both of these companies have proven track records and no glaring concerns. I expect both to be raising dividends for decades, although at slower rates.
Tier 2 - Core Companies
Company | Years | Concerns |
Altria (MO) | 51 | Cloudy future, future dividend growth rate |
AbbVie (ABBV) | 9 | Short history, future prospects, industry |
Walgreens Boots Alliance (WBA) | 45 | Management's ability to execute |
Cardinal Health (CAH) | 24 | Low dividend growth rate, lawsuits |
Healthcare Services Group (HCSG) | 19 | Low dividend growth rate |
U.S. Bancorp (USB) | 10 | Cut during GFC |
(source: Wyo Investments)
These examples are all quality companies, but certainly not as high quality as the ones above. Although each has concerns for me, the problems are not glaring weaknesses in my eyes. MO and AbbVie are of particular interest as they further demonstrate the individuality of defining buckets.
My position in MO was primarily established at the 2009 lows, although I also held some pre-split. Since 2009 the company has grown the dividend at close to 10% annually. However, an investor who recently started a position in Altria may have purchased simply for the yield and see muted growth prospects. This investor may choose to hold it in the "high yield" bucket. For the time being, I will keep it in my core bucket.
AbbVie has been a rare mix of dividend growth and yield. With a 5-year growth rate pushing 20%, some investors may hold it as a high-growth position, while others may have purchased it as a high-yield play as it could regularly be purchased with yields over 5% the last few years. I keep it in the core bucket because Abbott Laboratories (ABT) spun AbbVie - and Abbot has fantastic management.
However, I consider AbbVie of lower quality primarily because it relies on Humira and the fact that there are no pure-play drug developers in the dividend champions group. Eli Lilly (LLY) and Pfizer (PFE) are the only two that have reached champion status in the past, and LLY is the only one that has never cut the dividend. The odds don't seem to be in AbbVie's favor.
Other times, I will drop a high-quality company simply because it isn't achieving enough dividend growth to meet my goals. Cardinal Health and HCSG are examples of companies that are failing to meet my dividend growth targets. However, that doesn't mean I rush to replace them either, as I wrote about here. But they do get a little extra scrutiny.
Some companies look good on paper but don't have the history to justify placing them in the top tier. Most banks cut during the GFC, so they are suspect in the ability to grow the dividends for decades. Some companies may have frozen the distribution, such as CVS Health Corp. (CVS). While other companies, like Amgen (AMGN), have short histories but not the balance sheet of Apple or Intel.
Risks in the Core Bucket
Unlike the high-yield bucket, the risks in the core bucket are much more subtle. Risks to core companies are from complacency rather than greed and impatience. Of course, every company comes with risk, and investors should evaluate accordingly.
Probably the most significant risk with core holdings is getting too attached to a position. This endearment can lead to not recognizing a deterioration of quality. Part of this can be avoided by having a regular review of your core bucket and using a quality ranking system within it.
Probably the best way to combat complacency is to evaluate the thesis for owning a stock constantly. I find one of the best ways to do this is by finding opposing viewpoints. The best way to do this is by reading comment streams looking for contrasting views and reading bearish articles. Weighing my thesis from multiple perspectives keeps me grounded.
Summary
The core bucket is the driver of dividend growth within a DGI investor's portfolio. It contains high-quality, low-risk companies with long histories of raising the dividend. Using the Dividend Champions and Dividend Contenders is an excellent jumping-off place for finding these companies. These companies all have proven track records and have shown the ability to raise dividends through difficult times.
Of course, as with all stocks, every company has its risks. Companies change over time, and it's essential not to become complacent with the positions in this bucket. An investor should constantly be evaluating the thesis for holding a company as a core DGI position.
In part 3 of this series, I will cover the high dividend growth bucket. This bucket concentrates on companies with high dividend growth rates and tends to be more on the speculative side. I hope you are enjoying this series. Please let me know if you have any thoughts! Thanks for reading!
